Saturday, October 29, 2011

The Risk In Europe to USA is the Form Success in Remedy Takes

I will leave the analysis on the EFSF ability to reach in excess of $1 trillion, the banks in Europe recapitalization, and the decision making process in the implementation to others. This, of course, is the current form of the remedy offered to the ever chronic European financial crisis.

This remedy, in a long line of remedies offered to date, will fail though because of some of the developing factors provided below the failure will not occur until a decade or more “down the road”.

I sense that if this decade long “muddle through” fix is implemented - and although that will give some respite and a sense of cure for the immediate future – it will likely result to a catastrophe for the USA and present even a more serious risk in the future and also seriously weaken the global positioning and ability to provide security for the USA.

What I will address is my view that a “realist” foreign policy response to Europe that supports and works towards a “muddle through” results will be successfully reached, with the help of the USA. And that if a "realist" policy of "muddle through" is allowed , the current remedy offered by European leadership, a most serious risk to the USA will result.

What is the most important new development of late for the crisis is not from Europe, but it is that the general expectations of a USA “double dip” (which is really a euphemism for “depression”) will not be realized and in fact the USA is showing all the signs of a traditional economic recovery, though it has been delayed because of speculation in energy resulting in a $4.00 per gallon gas during parts of 2011, extreme supply disruptions from weather, and the Japanese tsunami. These were all exogenous shocks for the most part and the economy is returning to the systemic nature of the recovery. The monetary policy from the Fed has been of incredible brilliance – when history is written it will be noted the good fortune the country had a leading economic historian at the helm, who made his career focus understanding solvency and liquidity crisis, and who immediately responded appropriately. So, the US GDP has returned to the course set in 2009 which will be a capital expenditure and export led recovery, with general consumption returning. The allowed energy speculation is baffling in that it exists at such a critical time – all it requires is a policy response which “de-finacializes” the commodities in terms of not allowing financial players (and argument can be made that there is no such thing as a financial asset play in commodities – that they are a factor of production and not a form of savings or capital) “hedge” status in the markets and applying UBTI to non-profits from any commodity related transactions. Energy prices are directly the results of manipulation playing off the demand for futures and commodities by financial entities and have little to do with the fundamentals. So – the USA GDP was forestalled for a quarter or more in 2011 and is back on track as per expectations of 2009.

Why this is important is that the USA now has positioned, either realized by the leadership or not, itself to assist Europeans in any significant way required, and also that the USA financials have, or are now benefiting from this recovery, and have taken significant measures to firewall themselves from any contagion from Europe. This means that rather than being in a vulnerable position, the USA is actually in a position of great strength and that forward looking foreign policy can now be implemented in regards to Europe rather than being reactive and defensive. And it is important to understand the heart of the European crisis so as to realize that the ability to make strategic decision that will have long running impact on the nature of the European relationship is epic and if not seized upon and correctly defined, could be a catastrophe for the country in the long run.

Europe will require the USA participation from this point going forward until stability and “normalization” is regained in terms of governance and finances. But once such normalization is attained, Europe will quickly make clear it is not beholden in the USA and the foreign policy of Europe to date will be “carry on”.

That European foreign policy now is a weak “parasite” form, insisting the USA do the heavy lifting in terms of global security as well as shoulder all the accountability when hard power is implemented and the regrettable, but always existing, tragedies result. Libya is a classic example of this European foreign policy where a commercially inspired Europe first panders to Gaddafi with the Lockerbie bomber release and the Lady Ashton and British and French initiatives to secure various, mostly energy related, trade concessions. A foreign policy that despite all the criticism of the USA Iraq policy, is amoral and absent of values but for commercial gain and tempered with xenophobic fears of North African immigration. Then, as soon as it became clear that great commercial gains could be had with the deposing of Gaddafi, Europe turned on him and sought his ouster, and then insisted the USA follow and in the end do most of the heavy lifting. The European foreign policy is one of limited if no hard power capability, no ability to really defend their borders, no ability to project in international peace efforts, and happy to allow the presence of USA hard power in terms of naval power, intelligence and armed forces in Europe to provide basic security.

It should be clear that this foreign policy norm for Europe is required given the current confederation structure of the EZ and the EU, for without federation and union, no hard power can exist without causing serious internal concern. This foreign policy and near complete lack of hard power, served the USA purpose from post-WW II to the fall of the Berlin Wall. It contained Germany but allowed it to rebuild with dignity and as a friend of the other Europeans and it helped defend the West from the USSR as there was no question as to the need for and the validity of US troops in Europe. So the Europe as is now was encouraged and the strange witches brew of plutocracy and limited provincial governance was not only tolerated but encouraged. In any case it was impossible to build what unity that occurred without the absence of a significant German military capability, and therefore Germany could not allow for a powerful France. UK did not present a problem as untangling itself from an archaic empire presented such a cost the residual post-WWII UK military did not cause concern.

But those days are over. There is no threat from the USSR/Russia of significance. There is no need to have a toothless Europe, and in fact it is of great importance that to correct the instability that now exists from the uni-polar world of the USA hegemon, that another power develops to balance the USA. This will exist in any case and while most focus on China as that new power, it is best that Europe be induced to assume that role given compatibility to the USA and so many shared financial and corporate interactions and values.

So it is crucial a hard powered Europe quickly develop to balance and be the match to the USA.

Otherwise China will try to fulfill this role.

And hard power in Europe has to mean 2% to 5% of European GDP spent on military expenditures and a 1% of populace military force maintained and the ability to mobilize to a 10% of the populace military force is available in times of great emergency – all this must come about in Europe.

This can only take place with a united federation structure of representational democracy that has both the minority position able to express and protect their “rights” (in the USA this is the Senate and other non-direct population related institutions) as well as an Executive that can implement policy and protect across Europe. Only a federation of all of Europe can provide the legal basis and the justification and appropriate oversight to maintain a hard power.

The urgency of considering the above is understood after one understands the nature of the European crisis. The European crisis is not one of finance and debt and fiscal policy and taxation and bank capitalization – these are the symptoms of the problem, not the problem itself. Yet almost all are making a most serious mistake by dealing and considering only the symptoms.

The crisis in Europe is a constitutional crisis of the first order, along the lines of Alexander Hamilton or Jacque Necker or John MacDonald or Bismarck, it is the constitutional crisis that always comes about which forms successful sovereign unity or is the bases for failure, strife and chaos. Europe will sooner or later follow the lines of Hamilton or it will fail if it continues down the lines of the plutocratic and technical Necker. But given the above resurgence in the USA and thatthe USA can, and will, allow Europe to achieve either state, a choice is at hand for USA foreign policy which must be clearly understand in terms of the opportunity that it presents and the likely outcomes.

If the “muddle through” remedy is the choice, then the plutocratic Necker state will likely appease and maintain the current European power structure along the current lines, but it will fail in the end just as the government of Louis XVI failed. This technical and plutocratic form of government, with France and Germany forming a cabal which will be perceived soon by most, and now by Greece, as tyranny will end in strife, blood, and wrenching dislocations. The USA support for a “muddle through” would allow Europe to last this next 10 to 20 years in the current form. The USA should be prescient and look forward to what that ”muddle through” form means. It means a Europe ongoing experiencing ever more intense periodic social strife, Greece is already there and Spain unemployment benefits are now expiring with the rate well over 20%. Europe will be incapable in being a partner for the USA in any international security form as a technical confederation can never abide a sovereign hard power military force. Europe will be ever more cynical and always castigating the USA and promoting “soft power” and consensus and devices like carbon taxes and global warming to be used like the lines the Lilliputians used to tie down Gulliver, for a plutocratic form of governance with a tyranny of France and Germany is basically without values and will have to protect itself always by attacking the USA values incessantly. Europe will always be critical of any required international hard power projections the USA requires and always riding that option, ready to claim any upside from US blood, like the French energy companies swarming into Iraq and now Libya.

A “muddle through” answer now will remove Europe from being a meaningful ally or friend of the USA for the next two or more decades until Europe fails.

Therefore Europe will be much more than a distraction for the USA, for what will be different with Europe being Europe as they have thelast decade is that looking forward it is almost assured that a contest will develop between the USA and China .

In the next decade or two, likely becoming a need as soon as Afghanistan is settled and this financial crisis in Europe is remedied, one way or the other, it will be crucial that Europe be able to be present, with shared values, as an ally of the USA.

The current “muddle through” means Europe has not only insisted upon and received critical help from, but will have struck a deal with China which when disputes with China emerge, will sideline and perhaps even lead Europe to side with China.

Being a constitutional crisis and a moment of either nation forming or denying – there is a very limited time window for the USA to respond. For only during a constitutional crisis is their legitimacy in actions taken to form union. The USA has the capability to persuade Europe to form union, for at this time Europe require the USA support and help. If a “muddle through” stage is reached they will not require our interaction and in fact will be ready to repel any USA initiatives. So it is right now that the USA must apply a remedy to Europe which results in a positive for the USA strategically for the next decade or more. And given USA growth, then sense of crisis in the USA and in Europe will dissipate and the opportunity lost, likely by the end of this year.

Therefore the USA must insist upon Europe moving to constitutional considerations no more or no less than what American blood was shed for in Iraq. If a federal Europe results a representational democracy for all Europeans must result, and if it is a trans Europe unity resulting, then geographic units of Europe must have clear representational representation, a popular representation must be elected, a trans Europe executive must be popularly elected (not appointed), a constitution must be written and ratified, and key federal structures and devices implemented. There are certain “musts” in a federal sovereign: the ability to tax, the ability to adjudicate, a popularly elected parliamentary body and executive, and a body which maintains minority rights, a military, and a national police force. There are regular and required results for a federation: freedom of the populace to not only travel but to move with 3% to 10% moving per annum, equalization of transfer payments between regions of 10% of GDP, adherence to one body of federal secular law, the ability to conscript from the entire nation, a national debt, a national central bank, and a nationally applied taxation. To reach this state, the antithesis of “muddle through” must be insisted upon now. Of the above federal characteristics, only one exists in Europe at this time that is legally empowered and has a federal mandate – and that is the ECB.

There are likely other avenues the USA can take to induce federalism in Europe, taking advantage of this narrow window of opportunity, but I have identified two.

They are: 1) force Europe to develop hard power by removing US hard power from Europe; and 2) use the only true federal structure and mechanism in Europe, the ECB, to a posture such that union becomes a fait accompli.

The first channel, to remove USA hard power from Europe would present a crisis to Europe, a forced meeting reality as to what Europe requires for basic security. While nations will move to fill the vacuum after the USA force leaves Europe with crisis from what may appear to be an arms races developing between he likes of Poland and Germany, with USA persuasion and ongoing diplomacy and funding, the sense of a trans Europe army will be obvious. Of course to provide oversight, governance, funding and to implement use of the army requires a federal structure. The USA can make it clear, if it is not obvious to Europeans, that a France-German cabal will not be adequate or robust enough to administer this force. This is not creative, to develop security is the main reason sovereignty is established. This is just triggering a traditional and obvious causative for federal union. It is important that intense diplomatic initiative by the USA is provided to make sure certain geographic areas of Europe do not use this to become a dominant power. In any case, the time is now, for the positive results it will present to the USA for the USA to leave Europe – it is also inevitable for the USA to do so, so as to maintain our values and to show by action our statements as to those values. Of course security treaties such as NATO will be maintained and if anything, this move would dramatically strengthen NATO. Since this is a constitutional crisis occurring in Europe, this removal of USA forces in Europe would be the most powerful remedy to the financial problems as it would do the most to bring about the only long terms strategically viable remedy to Europe – union.

The second remedy, using the ECB to result in a federal union would be to again take a diplomatic initiative and correctly representing the USA long term interest, insist that the leverage and mechanistic approach of the EFSF and ESM path is not sustainable and will not be supported by the USA. Furthermore the USA will not tolerate the participation of China in the EFSF considering the blood and toil the USA has spent on Europe and the still existing obligations of Germany. That the current form of Europe was along a political pathway to answer the developments and needs of the West given the post WW II world, USSR aggression, and to help Germany rehabilitate itself and for the rest of Europe to repair. That it is in Europe’s interest to either devolve or to progress to a constitutionally backed democratic directly elected representational government and that means either devolution to the original EZ members and the elimination of the Euro, or the a unification of Europe along all vectors, not just that of financial union. The USA stands ready to fund and support either development, but strongly encourages the formation of the United States of Europe (a phrase used not long ago by almost all the leaders of Europe) and to maintain the Euro.

If union is sought, and a constitutional congress initiated for drafting , the USA will guarantee security for Europe during the period and will provide funding to maintain stability and to provide immediate remedy to the sovereign debt crisis. That the first step in this direction will be to move the ECB reserve position to match the reserve position of the Federal Reserve and to, over time, to unwind the other EZ central banks and centralize all monetary operations in the ECB. The USA, will acknowledging that the ECB is currently empowered to establish immediately a balance sheet that is equivalent to the Federal Reserve in size, stands ready to immediately fund via central bank swap lines up to $2 trillion in funding in either dollars or euros. Given the extreme vulnerability of the USA financial system during this transition this swap would be well within the mandate of the Federal Reserve. The swap would be will in accord with current central banking economic theory. In any case, either self-created or in partnership with the Federal Reserve, the ECB will then use the funding to buy “all” sovereign debt of the EZ members in proportion to their current percentage makeup of the current total sovereign debt outstanding. Par would be paid for all debt in the initial round of purchases and then market rates thereafter in competitive bids. Initial purchases will be made on a pro rata basis of size of ownership of the outstanding par amount of debt. The ECB may choose to sanitize this purchase with system reverse repos, or to allow the premium over current market price to stay in the system as stimulus.

It is an obvious example of the feeble current position of Europe and its inability to participate on a meaningful basis.

A ECB with Paragraph 7 (above) in their weekly report of at least $2 trillion would insist and force total union in all of Europe and would in an instantaneous time completely remedy the current financial crisis for it would be the start towards the sole and true cause of the European crisis – the constitutional crisis.

One major flaw in almost all market and economic analysis is function of lack of correct scaling in considering the placement of the USA in the world, and a failure of imagination to grasp the true size and scope and clout of the USA. The late Robert Eisner did wonderful work to help correct this error with his pragmatic analysis of the true nature of the USA fiscal accounts and budget. Eisner was one of the leading academics and authorities on the national accounting system used by the BEA. In the 1990s when all were panicking, Eisner in his series of works, one being "How Real is the Federal Deficit" and his other 'The Misunderstood Economy" saw that the crisis of the late 80s and 90s with the US deficit was in fact a chimera. Jane Jacobs has also made important contributions in perceiving the USA true global economic footprint with her description of the true economic geography of the USA. It is a serious error that Rogoff and Reinhardt are making in comparing and describing the USA current economic status in light of Sweden or Uruguay. Almost none of Rogoff et al work has any use in considering the USA. The USA is of such immense size and scale, that it defies current views. It is not an equivalent of France or Germany or China. China is a pipsqueak along side and in reality has some power a bit above Brazil. And so this error makes most completely miss that this crisis in Europe is almost over as the core problem that is somewhat analogous to Maine in size will be simply covered down. But the USA itself shares some of the error in terms of correctly understanding their capability, and so the above concern that the USA will assist in the "muddle through" is a serious risk given the general error even those in most senior positions are always making in regards to the USA size and placement in the world.

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About Me

Many years of experience in being a market maker, a trader, a salesguy or portfolio manager in almost all asset classes known. Have had a high teens average career return and yet can say that I have lost more money in more asset classes than anyone I know.
My biggest curse is that not even wishing to become involved: "I see dead people.", as the kid said in the movie. I can smell a trade in the drawer or financial fraud or PL blowup miles away. Should have been with the FBI if wanted to max social utility.
Autodidact in all things math, formal education in history.